Written by
Updated :
Reviewed by
If you are an employee who has worked in an organization for five years or more, you may be eligible for gratuity benefits. To explain simply, it's a monetary benefit that an employer pays to the worker for extended service that lasts a minimum of five years. While gratuity deduction may be present as a deduction in your salary slip, only the employer contributes towards this pay out. This is different from way Employee Provident Fund (EPF) works, where both the employee and the employer make equal contributions.
In this blog, we will discuss what gratuity is, how it is calculated and the key eligibility criteria for receiving gratuity pay out from your employer.
What is Gratuity?
Gratuity was introduced by the Indian Government through the Gratuity Payment Act, 1972. Before this, there was no mechanism in place that would allow such a payment. Gratuity is paid as a form of gratitude to employees for their extended service of 5 years or more to an organization.
As per the current rules of Gratuity Payment Act, there are two possible sources from which an employee can receive gratuity:
- From the company's account.
- From the organization's gratuity insurance plan.
The first case is a company managed account including a specific gratuity account that can contain funds to provide gratuity pay out. On the other hand, the company gratuity insurance plan works by covering the group i.e. employees in the organization, in case there is a need for gratuity payment.
Who is Covered Under the Gratuity Payment Act, 1972?
All companies that have more than 10 employees are covered under the rules mentioned in the Gratuity Payment Act, 1972. Additionally, all employees working in mines, shops, factories, ports, railways, plantations, or any other organization with 10 or more workers are also liable to receive a gratuity in salary.
If the employee fulfils the employment requirements and has been part of the company’s payroll for 5 years or longer, gratuity payment has to be made by the employer irrespective of the employee’s profession.
What are the Eligibility Criteria for Gratuity in India?
The basic requirement for gratuity in salary eligibility is that the employee should have rendered continuous service of a minimum of five years to a single organization. Apart from this basic criteria, here are some other rules that are applicable as part of the eligibility criteria for receiving gratuity in India:
Minimum Employee Strength:
Companies with an employee size of at least 10 on any single day in the past 12 months will be required to pay gratuity to their workers. The organization will need to do gratuity salary calculations even if the employee size reduces to less than 10 at a later date.
Retirement, Layoff and Other Conditions:
To receive gratuity, employees need to cease employment with the organization. One reason for this is retirement. Additionally, gratuity is also paid out under the following conditions provided the other criteria mentioned above are fulfilled:
- Resignation
- Voluntary Retirement Scheme (VRS)
- Lay off
- Termination
- Disability due to accident or illness
- Death
Retirement, Layoff and Other Conditions:
To receive gratuity, employees need to cease employment with the organization. One reason for this is retirement. Additionally, gratuity is also paid out under the following conditions provided the other criteria mentioned above are fulfilled:
- Resignation
- Voluntary Retirement Scheme (VRS)
- Lay off
- Termination
- Disability due to accident or illness
- Death
As long as an employee fulfils all the above criteria, he/she will be eligible for gratuity payment. Under current rules, gratuity payments need to be made to eligible employees even by organizations who declare themselves as bankrupt.
Reasons for Loss of Gratuity
There are however certain circumstances in which an employer might not need to pay gratuity to an employee even if all the above mentioned criteria are met. Common reasons why an otherwise eligible employee have to forfeit gratuity include:
- Being proven guilty of corruption at the workplace
- Violent act/disorderly conduct at/outside of the workplace
Apart from the reasons mentioned above, gratuity payments may also be lost in case of other proven workplace offences. In cases of proven negligence leading to damage to company property, the employer can deduct the cost of damages from the gratuity amount payable.
Gratuity Calculation Formula
The gratuity calculation formula as prescribed by the Gratuity Payment Act, 1972 differs based on the type of employment. The Act classifies employees eligible for gratuity payments into two distinct categories:
- Employees covered under the Gratuity Act, and
- Employees not covered under the Gratuity Act.
The below section discusses the calculation formula for gratuity in both cases:
Calculation for Employees Covered Under the Gratuity Payment Act
For employees covered under the Gratuity Act, the formula to calculate gratuity payment is:
Gratuity (G) = N x B x (15/26)
Here,
N= number of years of continuous service in the organization
B= last drawn basic salary
In this case i.e. for employees working in organizations covered under the Act, the number of working days in a month is considered as 26.
Calculation for Employees Not Covered Under Gratuity Payment Act
You are eligible to receive gratuity even if you work for an organization which is not covered under the Gratuity Payment Act, 1972. However, the gratuity calculation formula will be slightly different in this case as shown below:
Gratuity (G) = N x B x (15/30)
Here,
N= number of years of continuous service in the organization
B= last drawn basic salary
However, the difference in this case is that the gratuity is calculated using 30 days period as the working month instead of the 26 days period used in the case of employees covered under the Gratuity Payment Act.
Gratuity (G) = N x B x (15/30)
Here,
N= number of years of continuous service in the organization
B= last drawn basic salary
However, the difference in this case is that the gratuity is calculated using 30 days period as the working month instead of the 26 days period used in the case of employees covered under the Gratuity Payment Act.
Illustration of Gratuity Calculation
Now that you have a clear idea about gratuity calculation formula. Let us look at a few examples to understand gratuity calculations better.
Example 1:
Mr. Ravi works for ABC organization, which has an employee strength of over 100. He has resigned from the organization after working for 5 years 3 months. Ravi's basic salary was ₹80,000 according to last drawn salary. What will be Ravi’s gratuity amount?
Ravi’s gratuity payment = N x B x (15/26) = 5*80000*15/26 = ₹2.32 lakh
In the above case, 5 years 3 months has been rounded off to the nearest whole year i.e. 5 years.
Example 2:
Mr. Sachin has worked for XYZ organization not covered under the Act for 9 years 10 months. His basic salary for a month was ₹90,000 as per last drawn salary. What will be his gratuity in salary amount?
Gratuity (G) of Mr Sachin = N x B x (15/30) = 10 x 90000 x (15/30) =₹4.5 lakh
In the above case, the 9 year 10 months service period has been rounded to nearest whole year i.e. 10 years for the purpose of the gratuity calculation.
Example 2:
Mr. Sachin has worked for XYZ organization not covered under the Act for 9 years 10 months. His basic salary for a month was ₹90,000 as per last drawn salary. What will be his gratuity in salary amount?
Gratuity (G) of Mr Sachin = N x B x (15/30) = 10 x 90000 x (15/30) =₹4.5 lakh
In the above case, the 9 year 10 months service period has been rounded to nearest whole year i.e. 10 years for the purpose of the gratuity calculation.
Tax Rules for Gratuity on Salary
Gratuity in salary is exempt from tax in many cases as long as you have submitted Income Tax Form 10E to submitting your Income Tax Return. There is also an upper monetary limit of Rs. 20 lakh up to which gratuity payments are exempt from tax. So if an employee receives gratuity in excess of ₹20 lakh during his/her lifetime, the incremental amount will be taxable as per the slab rate for the applicable financial year.
Let's have a detailed understanding of conditions in which tax is not levied on gratuity payments:
1. The gratuity amount is received by central and state employees, defense forces employees, and municipality employees
2. Any gratuity amount under the maximum limit of ₹20 lakh is disbursed tax-free.
Conditions in which tax applies to payments are:
1. The cumulative gratuity amount received during the employees’ lifetime exceeds ₹20 lakh. Tax will be applicable only on the amount exceeding the ₹20 lakh limit.
2. The gratuity amount is received by the nominee in the case of the employee's death. In this case, gratuity is taxed under the head Income from Other Sources.
Frequently Asked Questions (FAQs)
Q. Does sabbatical leave affect gratuity?
A. Many employees take a sabbatical to take an extended break from work due to illness, a family emergency, etc. In the case of sabbatical leave approved by the organization, the employee may continue to be considered as being in continuous service. However, the guidelines for this might differ from one company to another.
Q. How can the gratuity payments be made?
A. The gratuity payment can be made in cash, cheque, demand draft or direct account deposit as per agreement between employer and employee. Note that any employee who hasn't completed five years in an organization doesn't qualify for gratuity.
Q. What is the timeline for gratuity payment?
A. There are two timelines that employers and employees need to adhere to. First, the employee eligible for gratuity must apply for it within 30 days from the date it becomes payable. Second, the employee needs to disburse it within 30 days of receiving the completed application from the employee.
Q. Can an employee nominate somebody to receive their gratuity amount in case of death?
A. Yes, an employee can nominate anybody they wish to for receiving their gratuity amount. All they need to do is fill up Form F of gratuity in salary upon joining the company to provide nominee details. Also do remember that gratuity payments received by a nominee may be subject to tax as per the applicable income tax slab rates.
Q. Can I get gratuity even if I am not covered under the Gratuity Payment Act?
A. Yes, you can receive gratuity payment even if you are not covered under the Gratuity Payment Act, 1972. However, the gratuity calculation formula is different for employees covered under the act vs employees not covered under the act.
Sources:
https://www.adityabirlacapital.com/abc-of-money/what-is-gratuity
https://economictimes.indiatimes.com/wealth/earn/what-is-gratuity/articleshow/62047880.cms
https://razorpay.com/payroll/learn/what-is-gratuity/
https://www.taxmanagementindia.com/visitor/detail_article.asp?ArticleID=8130
https://scripbox.com/plan/gratuity-calculator/
https://www.adityabirlacapital.com/abc-of-money/effect-of-sabbatical-leaves-on-gratuity
https://economictimes.indiatimes.com/wealth/earn/what-are-the-gratuity-payment-rules/articleshow/62334282.cms
ARN No : Nov22/Bg/09